CH10: Fiscal and Supply side policies

Question 1

Definition: Fiscal policy

Answer 1

The management of the economy using government spending (injections) and Tax (withdrawals)

Question 2

How do governments GROW the economy using FISCAL POLICY?

Answer 2

Increase gov spending hence injecting more money into the economy

Reduce taxation, hence reducing withdraws from the economy

Question 3

How do governments SLOW growth of the economy using FISCAL POLICY?

Answer 3

Reduce public spending

Increase taxation

Question 4

Why is taxation used?

Answer 4

to raise funds for governments- money raised is known as the public finance

Question 5

What are the 3 main purposes of taxation?

Answer 5

To allocate resources efficiently - intervening in market failure situations: funding merit goods eg. healthcare, discouraging demerit goods, and providing public services eg. education.

To distribute income more evenly, or to meet certain needs - eg. via social security payments such as unemployment pay

To manage the economy - by taking more to less money out of the circular flow

Question 6

What is the difference between direct and indirect taxes?

Answer 6

Direct - tax on people’s/organisation’s earnings or increase in wealth.

Indirect - taxes which are imposed on one section of the economy (eg. companies), but it is intended that the burden of paying the tax will be borne by another section of the economy (individuals). eg. VAT
ie. tax placed on good and services rather than on income or profits.

Question 7

What is Ad Valorem taxes?

Answer 7

eg. VAT, sales tax, where the tax is charged based on the value of the transaction/ % of the value of the product

Question 8

Unit taxes

Answer 8

Expressed as a value in currency related to a specified QUANTITY of items sold or weight of an item eg. tax on a pack of cigarettes

Question 9

Excise duties

Answer 9

tax levied on the sale or use of certain products eg. tobacco, alcohol, energy, mineral oils, vehicles. They can be charges as either an amount per quantity (UNIT TAX) or % of the value of the product (Ad Valorem)

Question 10

Wealth taxes

Answer 10

Charged as a % of an individual’s wealth annually

Question 11

Consumption taxes

Answer 11

Taxes on the purchase value of goods or services.
They can be SINGLE STAGE (levied only at one stage in the production/sales process)
or MULTISTAGE (levied every time the product is sold)

Question 12

Property taxes

Answer 12

Levied on the sale or rent of property eg. stamp duty

Question 13

What is the effect of PROGRESSIVE tax?

Answer 13

As income increases, the % paid in (progressive) tax increase. ie. high income earners pay more as a result vs. low income earners.

eg. income tax in UK

Question 14

What is the effect of REGRESSIVE tax?

Answer 14

As income rises the % paid in (regressive) tax falls.
Low income earners pay more s a % of their earnings.

eg. VAT, sales tax

Question 15

What is the effect of PROPORTIONAL tax?

Answer 15

As income rises the % pain in tax stays the same.

High and low income earners pay the same % of their income in tax.

Question 16

Definition: Public sector net borrowing

Answer 16

The amount government borrows to cover the shortfall between taxation revenue and government spending

Question 17

Definition: Fiscal deficit aka Budget deficit or an expansionary fiscal policy

Answer 17

government spending is GREATER than taxation revenue

Question 18

Definition: Fiscal surplus aka budget surplus

Answer 18

Taxation revenue (public finance) is GREATER than government spending

Question 19

Balanced budget

Answer 19

Taxation revenue = government spending

Question 20

What are advantages to a Fiscal deficit?

Answer 20

Increased growth in the economy (boosting demand and growth)

Question 21

What are disadvantages to a fiscal deficit?

Answer 21

Note. the public sector net borrowing would be higher when there is higher shortfall between tax revenue and government spending (ie. in the case of a fiscal deficit)

higher borrowings (by the government to finance the gov spending) could mean:

• Higher interest rates - the gov may need to pay higher interest rates to encourage people to lend to them. this may result in higher interest rates for everyone, making everyone with loans worse off.
• Higher interest payments - higher borrowing means there will be more interest for the government to pay in future hence there will be less to spend on services such as education, defence and healthcare etc.

Question 22

Name the 2 types of budget deficit

Answer 22

Cyclical

Structural

Question 23

What is a Cyclical budget deficit?

Answer 23

This is linked to the trade cycle.
A deficit often rises when the economy is on a downward trend, as governments spend more and taxation levels drop. NOT A HUGE PROBLEM as it will be offset by a surplus when the economy goes into the upward cycle.

Question 24

What is a Structural budget deficit, and how does this arise?

Answer 24

arises from a more permanent imbalance in the budget and leads to an ever growing national debt.

can arise from:

Ageing population
Resistance to pay taxes
Resistance to reducing public expenditure
Development of the economy
Wage inflation- if wages rise public spending to healthcare and education professionals will also rise

Question 25

When does a balanced budget occur?

Answer 25

1. The gov does not want to grow or slow growth of the economy
2. The gov is using monetary policy rather than fiscal to manage the economy

Question 26

What are Gov spending supply-side policies?

Answer 26

spending on:
Education
Healthcare services
Infrastructure

Question 27

What do examples of other supply side policies involve?

Answer 27

encouraging competition and investments

improving effectiveness of labour

Question 28

What are policies to encourage competition?

Answer 28

Privatisation

Deregulation - allowing private sector to compete with state owned business

Question 29

What is an advantage of supply side policies vs. Fiscal and Monetary?

Answer 29

Less likely to cause inflation and less likely to impact national debt (applies to fiscal policy)